Report

How to price carbon in good times… and bad

At a Glance

Responsive cap-and-trade systems and carbon taxes can improve climate change policy by allowing higher greenhouse gas emissions during times of economic expansions and lower emissions during recessions, according to a new report published today (12 December 2014) by the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science.The author of the report, Dr Baran Doda, argues that although it is better to build in responsiveness at the outset, carbon pricing instruments designed with a fixed ‘cap’ or tax rate could be ‘retrofitted’ to respond to economic shocks. When combined with an appropriately selected long-term target, responsive carbon pricing schemes provide better incentives to reduce emissions in times of boom and bust alike.The findings are in line with a recent proposal to establish a market stability reserve for the European Union Emissions Trading System (EU ETS).The report states: “A well-designed system can prevent prices from falling too low during a recession and so maintain the abatement incentive, or from overshooting in a boom and excessively constraining production by regulated firms precisely when they are at their most productive.”

Allowing greater emissions in years of above average economic growth would not affect overall climate change mitigation, since the increase is compensated for in years of below average economic growth.